- TGI is trading at an excessively cheap valuation due to a few years of poor management.
- Management changes in recent years are bringing back a much needed operational focus.
- This new focus on execution has already begun to pay off and will enable the valuation to normalize as revenue growth returns and margins normalize.
Triumph Group (NYSE:TGI) has been selling off for the past few years due to several years of weak management and is trading at a valuation significantly below its peers as a result. Management changes and initiatives over the past two years have been dramatic and are on the cusp of making their way into the financials in a significant way. Triumph provides the opportunity to buy a mediocre business with great management trading at levels that are reflective of a poor business with terrible management. For this reason, it is reasonable to be bullish on the company as the market begins to reprice the equity to reflect the improvement in execution.
Triumph is essentially a conglomerate of small companies that each manufacture unique products for commercial and defense applications in the aviation industry. About 35% of revenue comes from products/services that are higher margin businesses due to the specialization and need for quality associated with them (These generally fall under the Integrated Systems and Product Support umbrella). The remainder of revenue comes from products with more commodity like characteristics that are sold to customers with significant negotiating leverage due to their size and thus generate low margins and returns on capital (These generally fall under the Precision Components and Aerospace Structures umbrella).
TGI's equity has been underperforming the market for the past 5 years for reasons that are well documented, but can be aptly summarized as incompetent leadership. Triumph embarked on a spree of acquisitions from 2010 to 2015 and failed to create value in these acquisitions. Poor expense management led to a deterioration in margins, and a lack of operational rigor led to a deterioration in customer relations. Northrop (NOC) placed Triumph on its no bid list and Boeing (BA) (a company responsible for ~35% of its sales) was on the brink of doing the same.
This made it difficult for Triumph to win new contracts. Triumph's backlog began to decline and the top-line growth turned negative. This only exacerbated the expense management problem and the income statement turned into a mess. As a result of these missteps by management, Triumph now trades at a healthy discount to its peers and its historical valuation. This discount is unlikely to remain in the next couple years.
Daniel Crowley was appointed CEO in January of 2016 and inherited an absolute mess. He has taken decisive action so far in his tenure by simplifying the business: selling off assets, consolidating business units and shrinking/closing underperforming units. He has overhauled the management team and is aggressively pursuing a cost saving initiative to pull out $300M in expenses by the end of FY 2019 and is on track to do so. He has improved customer relations in a tangible way as Triumph is no longer on any no bid list and no program in production is currently behind schedule.
The market's hope for a turnaround is near an all-time low just as Triumph is reaching an inflection point where the initiatives being pursued over the past 2 years by the new CEO - operating efficiency, product innovation and execution - have the greatest likelihood to begin showing up in the financials. Prior cost savings initiatives have been masked by declining revenues and restructuring charges, both of which are likely temporary in nature.
Trends in the backlog are the best leading indicator for revenue for manufacturers like Triumph, and for the first time in two years, the company is beginning to see growth instead of declines in its backlog. This bodes well for FY 19 revenue and is a trend that is reflective of the great work that has gone into improving customer relations.
As the growing backlog flows into the top line, we will see margins begin to widen as the effects of cost savings become more apparent. Even if we assume that net margins are at 5% (the low end of where they were before the revenue deleveraging), the company would be poised to earn ~$3 per share with just minimal revenue growth (also keep in mind tax rates were in the low to mid 30s for this net margin comparison):
There's quite the margin of safety here and the potential for significant outperformance if Triumph continues to deliver on operational excellence and growth in its backlog.
This article was written by
Analyst’s Disclosure: I am/we are long TGI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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